How to cash in on intra-day volatility

Volatility is no longer being shunned by retail investors these days. In fact, a new breed of investors has emerged which likes to play with the market and is ready to take risks. This is a far cry from the days when retail investors used to play safe and invest with a long-term horizon.

Further, since these are uncertain times in the stock market, the indices and individual stocks have started dancing in tune to the movements in overseas markets.

Given the turmoil in global markets, it is become increasingly difficult for traders and investors to make profits, since all decisions at the global level affect the domestic market as well. Perhaps the only way that retail investors or traders can extract profits from the stock market is to make the most of the intra-day volatility seen in highly liquid stocks, rather than carrying forward their risks.

To provide a reckoner on volatility for this set of investors, ET Investor���s Guide examines the intra-day volatility of constituents of the Nifty 50 and Nifty Junior stocks for the period January-November ���08. The exercise involves calculating the daily volatility for 221 sessions so far and arriving at the average volatility on the basis of this.

Volatility refers to the variation in the value of the underlying and thus measures its instability. Though volatility is generally perceived to be negative, indicating high risk, it can be turned to an investor���s advantage if s/he buys at the day���s lows and sells at the day���s highs. While there are complicated mathematical ways of calculating volatility, a simple method is by looking at the highest and lowest value of the stock.

For example, if a stock had a price range of Rs 900-1 ,100 on a day, then its volatility for the day will be 200 divided by 1,000 (the average value), expressed in percentage terms. The volatility in this particular case works out to 20%.

Our analysis shows that Housing Development & Infrastructure (HDIL) has the maximum average volatility during this period at 9.1%, with the highest volatility of 34.9%.

This is followed by Unitech, with average volatility of 8.5% and highest volatility of 75.6%. The top 10 companies have average volatility ranging from 7.6% to 9.1%. This means that if an investor had taken an exposure of Rs 100,000 each in the top 10 stocks at the day���s low and sold at the day���s high, s/he would have made a total gain of Rs 80,187, or 8.02% of the exposure taken, on an average day.

Even if an investor is able to encash 50% of the total gains available through intra-day volatility, s/he would have made a total gain of Rs 88.6 lakh on an exposure of Rs 10 lakh ��� which is almost nine times the exposure taken over a 10-month period! If you think capturing even 50% value is too much and requires a lot of skill, settle for 10%. Even that will give you about Rs 18 lakh within 10 months!

There is scope for an even higher risk and better returns than what we have mentioned so far. This is possible in case of intra-day players who take positions to exit them on volatility at a suitable time during the same session, in the futures and options segment.

What is even more interesting is that the exercise requires a very small capital base in hand ��� only to offset the maximum losses that an investor undertakes in case s/he continuously goes wrong for a week or so. However, to be on the safe side, a retail investor can make the most of this intra-day volatility by keeping some strict stoploss options on a daily basis, to ensure that his losses get restricted on days when his calls go wrong.

Our analysis shows that the most volatile stocks are concentrated in the real estate and financial services sectors. Among the top 10 most volatile stocks, three are from the reality sector, while two are from the financial sector. It may be noted that these sectors displayed maximum volatility during last year���s bull run as well. The list also includes names such as Moser Baer and Suzlon Energy, which have become highly volatile in recent times because of various company-specific factors. While there are no trends in terms of promoter group, there are three companies from the Reliance ADAG group among the top 10 volatile stocks.

On the other hand, as regards intraday traders who like to play safe to ensure that their risks get minimised, our study reveals that even the least volatile stocks among the Nifty 50 and Nifty Junior constituents display average intra-day volatility of 3.9-4 .8%.

These stocks mainly belong to the FMCG and pharma sectors. They include companies such as Cipla, Sun Pharmaceutical, Cadila Healthcare, Aventis, Hindustan Unilever, ITC, Asian Paints, Container Corporation and Infosys Technologies. Even capturing half of that volatility, say 1.75-2 % on every trading day, will benefit investors, considering that returns are not available by investing in a falling market.

Although the sectoral thrust of last year continues, the future may not be a replica of the past. The sectoral focus keeps changing with a varying macroeconomic environment, diverse consumer preferences and government policies. For investors who want to cash in on the intra-day volatility, the real art lies in being aware of the changing market dynamics.